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1 March 2012

The State as Sentinel Part I

Catch-up Strategies in the Far East


Since the earliest times, the history of economics has been marked by the fundamental collision of two confl icting approaches regarding the question of economic development, those of the faithful adherents to the principle of the free market on the one hand, and those of the devotees of the strong, engaged state on the other. The outlines of this opposition already began to appear in the earliest schools of economics in the views of the physiocrats and the mercantilists, but the two conflicting systems of thought emerged clearly in the 19th century in classical English economic theory (the principal representatives of which were Adam Smith and David Ricardo) and, on the other end of the spectrum, the views of American and German economists (first and foremost Alexander Hamilton and Friedrich List).

According to the adherents to the principle of free trade, the economic prosperity of the world is furthered if governments pose no obstacles to free trade, if they get rid of protective tariffs and limits on quantity, and forego any support for local or domestic enterprises and open their economies to foreign investment. In contrast, believers in the power of the pro-active state are convinced that in the case of underdeveloped countries free trade offers no mechanism or guarantee of growth, but merely allows more developed countries to consolidate their power over the less prosperous. In the middle of the 19th century Hungarian statesman Lajos Kossuth, infl uenced in part by the teachings of German economist Friedrich List and weighing these considerations, struggled to help Hungary achieve its independence.

By the end of the 20th century, devotees of free trade had risen to positions of prominence and power all over the world, whether as university professors, leaders of international organizations, or in some countries infl uential members of economic ministries. At the close of the century and the dawn of the 21st the countries of Central Europe, and Hungary in particular, were among the most ambitious students of the principles of free trade, partly in the hope of finally managing to bring to an end a century of economic backwardness (Botos, 2008). The results of the economic policies of the past two decades, however, have hardly fulfilled these hopes. Between 1988 and 1994, the average per capita domestic income, perhaps the most general measure of economic development, dropped by 20 per cent, and it was not until the year 2000, following a period of growth that began in 1994, that per capita domestic incomes returned to 1988 levels. Since 2007, following a period of rapid growth that lasted some four or five years, the Hungarian economy began to slow down again, and in 2008, it shrank by 8 per cent. As a consequence, the economic disparity between Hungary and Austria did not diminish following the fall of communism in Hungary, as had been hoped, but rather grew. While in 1980 the average per capita domestic income was exactly 50 per cent of the average per capita domestic income in Austria, by 2010 it dropped to 47 per cent.

Over the course of the 20th century various countries of Europe, perhaps fi rst and foremost West Germany, have demonstrated quite clearly by example that in its efforts to regulate and participate in the economy the state can play a very signifi cant role in the competition with a developed market economy (as for instance the German state did at the time with Great Britain, see Bod, 1987). In the second half of the 20th century, however, the effectiveness of state regulation in the promotion of economic growth was the most salient in the formerly colonized, newly independent states (Wonik, 2009). In the 1990s, there were debates regarding the extent to which the economic successes of many of the countries of Asia could be attributed to the conscious strategies of the governments of these states, but by the first years of the 21st century, this view has gained widespread consensus. This was particularly true given the dramatic economic decline suffered by many of the states of Latin America in the last decades of the 20th century, as these states had adopted policies (the so-called Washington consensus) that essentially deprived the state of any role in promoting economic development and favoured instead the free market (Kőrösi, 2008).

In the period following the fall of communism in Hungary, the question was often raised as to which economic model the country should follow, which economic region it should attempt to join, and what the nature of this association should be. In practice, over the course of the past twenty years Hungary has adopted essentially liberal economic principles (in the classical sense), the recommendations of the Washington consensus, and it has rapidly integrated into the Western European economic sphere. This integration took place in such a manner, however, that the participation of the Hungarian economy involved primarily small value-added endeavours, while within the system of larger enterprises the Western European and North American international companies acquired dominant roles. These international businesses did little to bring high value-added activities to Hungary, but rather used their presence in the country simply for the assembly of products designed in Western Europe, first and foremost with the assistance of subsidiary firms. Apart from an ever-smaller number of exceptions, domestically owned enterprises were only able to find a place in the economic sphere of Western Europe at the bottom of a chain of subcontractors and suppliers.

The unambiguous failure of the past twenty years raises the question as to what should have been done and what should be done differently. With regards to this question, the example of China is often instructive. As is now commonly acknowledged, in China the transition came about considerably more slowly, and during the course of the shift the Chinese state played a signifi cant role in promoting development, strengthening domestic enterprises to such an extent that today they have become serious competitors in the international marketplace. Chinese businesses and companies are increasingly hesitant to content themselves with small value-added activities, but rather move ever more often and ever more resolutely towards high-value added endeavours, presenting products on the global market that they themselves have developed (or in many cases imitated).

The example of China may also be instructive to economists considering the underlying reasons for the failures of the Hungarian economy over the past twenty years because, as is increasingly apparent, China has learned a great deal in the course of the adoption of principles of the free market from the so-called New Economic Mechanism introduced in Hungary in the 1960s. China, in contrast, did not follow a path of unrestrained privatization, deregulation, and liberalization following 1990, but rather continued to proceed cautiously, deliberately, allowing a degree of economic liberalization that answered the needs of the Chinese economy (Árva – Schlett, 2011).

From many perspectives, however, China cannot be considered a genuine example for Hungary to follow, for instance simply because of the vast difference in the sizes of the two countries. The population of Hungary (10 million) is minuscule compared to the population of China (1.3 billion), and one cannot fail to consider that China has an arsenal of nuclear weapons, while Hungary would be unable to defend itself effectively even in the event of a localized regional conflict.

Must one then abandon the idea of finding a suitable example of economic development in Asia that also addresses national interests? Most certainly not, and while China and Hungary may not be in the same weight division, as it were, there are several other countries in the Far East that are and that nevertheless have been able to assert and defend the interests of their national economies over the course of the past thirty years, in spite of the fact that they set out from positions as politically and historically problematic as that of Hungary. These countries include South Korea, Singapore and Malaysia.

Taiwan, Malaysia, and South Korea, countries of the Far East that are approximately the same size as Hungary, have done far better than we did, while never going nearly as far as Hungary in their adoption of the principles of the free market. In 2010 Taiwan (with an average per capita income of 35,227 USD) and South Korea (29,836 USD) far outperformed Hungary (18,738 USD), and even came close to catching up with Austria (39,637 USD). Malaysia (14,670 USD) did not outpace Hungary, but it did come quite close to reaching a similar level of economic growth. In the case of Malaysia, however, one must not neglect to consider that between 1980 and 2010 the population almost doubled, so the figures regarding average per capita domestic income are smaller than in the case of Hungary, where the population has decreased.

In the case of the rapidly developing countries of the Far East, economic growth was not based on raw materials and sources of energy (indeed Malaysia, the country with the greatest wealth of raw materials and sources of energy, was the slowest among the rapidly developing countries of the region, and neither South Korea nor Taiwan has significant amounts of either). Today economists and analysts are increasingly reaching a consensus. The successes of the countries of the Far East are due to their industrious and highly disciplined work forces, but perhaps more importantly to the economic policies of their governments, which play a very deliberate and active role in promoting economic stability and growth.

MALAYSIA: AT THE CROSSROADS OF THE WORLD


Historical antecedents


In the mid-1960s, when Malaysia became independent and set off down the road towards economic development, it was beset with political tensions, which were due primarily to the fact that, like Hungary, Malaysia is located at a geographical crossroads where numerous religions, ethnicities, and ideologies have met and at times collided over the past several centuries. And as in the case of Hungary, these tensions created considerable obstacles that the state had to address in the fi rst years of its newly won independence.

The Malaysian peninsula and the Western islands of the Indonesian archipelago have traditionally functioned as a natural stopping point for Indian merchants travelling East and Chinese merchants travelling West, where they were able to harbour their boats and wait for the monsoon winds to shift. The Malaysian peninsula stretches from North to South, and anyone seeking to sail from India to China or China to India must travel its length, a voyage made diffi cult by the fact that the monsoon winds blow from North to South in the winter and South to North in the summer. The first inhabitants of the peninsula were the so-called proto-Malays, peoples related to the Australian aborigines. Since the third century AD, various other peoples have arrived from the North, and together with the proto-Malays they now constitute the Malay people. Chinese and Indian merchants and seafarers settled in the peninsula alongside the proto-Malays before the third century, creating an ethnic and religious diversity that is still very much part of the country’s culture today. From the perspective of religion, Hinduism and Buddhism were the fi rst systems of belief to spread, and in the 15th century Indian merchants began to bring Islam to the peninsula, an infl uence which spread to the islands of Indonesia as well.

Also beginning in the 15th century European powers gradually brought the Malaysian peninsula and the Indonesian archipelago into their spheres of infl uence. In the 19th century the territory we know today as Malaysia came under British control and took a path of dramatic economic development. The British launched ambitious projects involving the construction of railways and pewter mines, which brought throngs of Chinese labourers to the previously sparsely inhabited peninsula. During the period of British rule many Indians also arrived in Malaysia, working in part in the British civil service and in part as merchants and entrepreneurs. The Indians were primarily Hindus, though there were also Muslims among them. The Chinese immigrants to the peninsula preserved their religious practices, and remained quite separate in this regard from the other inhabitants of the country. Some of the Chinese workers soon found a place in the world of trade and commerce and, along with the Indians, gradually began to dominate economic life (Khoi, 1971).

In the Second World War the British suffered a quick and humiliating defeat at the hands of the Japanese in Malaysia, and were only able to reassert their rule on the peninsula following Japanese defeats in the Pacific sphere of war. The Second World War had two important consequences for Malaysia. First, the British, and thereby the West in general, suffered a significant loss of prestige, and second, the Chinese minority ignited a Maoist uprising, using weapons that had either come into the hands of guerrillas during the war or been left behind by Japanese forces. The British were able to suppress the uprising, but only with considerable effort before the country obtained its independence, and the ethnic and political tensions posed a continuous threat to stability and consolidated rule.

The history of Malaysia’s independence is long and complex, not simply because of the role played by the Maoist uprising, but also because of the fact that it was never entirely clear which territories would become part of the country. In 1963 Singapore joined the state formation, which at the time was referred to as the Federation of Malaya, as did three Sultanates from the island of Borneo, but Singapore, which is inhabited primarily by Chinese, quickly separated from the Federation in 1965.

Thus, following independence, Malaysia had to address numerous challenges arising from its ethnic, religious and political diversity:
The country was relatively small, with a population of barely 10 million. Furthermore, the population lived in two territories separated by the sea, the more densely populated Southern stretch of the Malaysian peninsula on the one hand and the more sparsely populated Northern part of the island of Borneo on the other, which is covered with jungle and virgin forests.
The economy of the country was underdeveloped, dominated primarily by caoutchouc and pewter production.
60 per cent of the country’s population was either Malay or belonged to one of the native tribes, while 30 per cent was Chinese and 10 per cent was Indian.
The Malay communities were the most economically underdeveloped, while the Chinese and to a lesser extent Indian populations controlled industry and trade. Furthermore, in the wake of the uprisings led by the Chinese, which had lasted over a decade, ethnic tensions were fierce.

From the perspective of foreign policy, Malaysia constituted a stark contrast with the countries immediately surrounding it, not to mention China.

Singapore, 95 per cent of the population of which was Chinese, was not willing to accept Malaysian rule and after two years declared its independence from Malaysia. Relations between the two countries continued to be rife with tension.

Given these economic, ethnic, and political circumstances, it was perhaps hardly surprising that in the early 1960s very few people thought Malaysia had a bright future. The situation was exacerbated by the fact that the pewter mines and caoutchouc plantations, which were in the hands of the British, were seized by the government, and their owners quickly fled the country, taking their expertise with them.

Thus following independence Malaysia found itself in circumstances that were less than enviable, to put it mildly. Nonetheless, Malaysia has been able to maintain political stability and peace and the country’s economic growth has become something of an example to be followed, a success illustrated clearly by the fact that between 1980 and 2010 the difference in per capita income between Malaysia and the developed world has dropped. While in Hungary in the 1980s the per capita domestic income (taking into account differences in prices) was 5,820 USD according to the IMF, in Malaysia it was 2,680 USD, in other words less than half (one might say, a bit imprecisely, that Hungary was twice as developed as Malaysia). Today in Hungary the per capita income is 18,700 USD, while the per capita income in Malaysia is 14,670 USD. Using the same admittedly slightly imprecise manner of comparison, Malaysia has thus reached 80 per cent of Hungary’s level of development. But if we were to take into consideration one of the neighbouring countries, such as Romania, the comparison is even more interesting. In 1980 Malaysia lagged far behind Romania, but today the tables have turned and Malaysia, according to the same measure of economic prosperity, is at least 10 per cent ahead.


The most important aims, methods, and results of economic development in Malaysia



After having adopted an impatient approach to politics in the first few years after Malaysia gained its independence, the National Front, which has governed to this day, was able to find a compromise satisfactory to the Malay, Chinese, and Indian constituents of the electorate relatively quickly, a compromise that ensured each a voice in politics. Mahatir Mohamed contributed substantially to the political stability, serving as Prime Minister from 1981 to 2003 and retaining considerable power even since.

Regarding economic development, since independence the Malaysian governments have always had two fundamental priorities. They sought to strengthen the role of the Malay majority in the economic life of the country and to implement economic policies that would help Malaysia join the countries of the developed world.

The government used numerous tools to nurture economic growth among the Malay communities of the country, from investments in education to fi nancial support for Malay entrepreneurs. It even went so far as to require Malay to be included in management and leading positions in businesses. The “DasarEkonomiBaru”, or New Economic Policy was adopted immediately following independence, and while in principle it reached its end in 1990 some elements remain in effect to this day. This policy is credited with having brought about a tremendous shift in the economic prosperity of the Malay. In 1970 the Malay controlled only some

2.4 per cent of the country’s capital, but by 2004 this figure had risen to 18.7 per cent. The dominance of the Chinese in the economic life of the country has declined, but according to some estimates 70 per cent of the country’s capital is in the hands of this minority, which constitutes less than one third of the population.

Malaysia’s real triumph lies in the successes it has achieved in the growth of its national economy. By implementing carefully deliberated economic policies centred on state planning and control, the government has managed to make Malaysia the 29th wealthiest country in the world in absolute terms and the 41st from the perspective of per capita wealth. It has continuously moved up the ladder of economic prosperity, while Hungary has continuously moved down, now at 31st place, while Romania is at 43rd. Malaysia’s economic growth has been particularly rapid over the past decades. Its average yearly per capita GDP growth between 1957 and 2005 was 6.5 per cent. The country has become one of the leading producers of semiconductors and devices related to communications and informatics, and Kuala Lumpur is today one of the financial centres of the region. Economic growth was undoubtedly furthered by the fact that the country has significant natural resources, from pewter to oil, but one should note that unlike many other oil producing countries, Malaysia does not squander the profi ts from the sale of its natural resources on luxuries, but rather invests them back into economic development as part of deliberate government policy.

In the first decades of this period of economic growth, the government pursued industrialization to replace imports, protecting domestic industry with high customs duties and giving financial support to local enterprises. Following the successes of these decades, in the 1970s government leaders sought to reorient the economy around emerging sectors, so the country opened itself to foreign investment. This move was cautious, however, and initially foreign buyers were only allowed to purchase assets owned by members of the minorities. The government also strove to ensure that Malays would play an increasingly large role in economic life.

From 1970 on, investments of foreign capital played an ever-larger role in the Malaysian economy, but this was never sudden. Rather, the country’s economy was opened gradually to foreign investors. For some time the government set “performance requirements” for foreign investors, specifying the size of the labour force they would have to employ and the percentage of their production they would be allowed to export, and even obligating them to use local suppliers and subcontractors (Wade, 1991).

In the interests of defending the domestic economy, foreign investments in Malaysia were directed primarily towards exports, which is signifi cant simply because the high protective tariffs played an important role in the protection of domestic industry until the end of the 1980s, and the system was only dismantled gradually. If foreign investors had been allowed to bring their businesses to Malaysia without any restrictions or checks, the protective tariffs would have become ineffective and the multinationals would have easily been able to squeeze local competitors out of the domestic marketplace. For this reason, regulations were in place for some time, according to which the permitted proportion of foreign investment was linked to the percentage of production made for export. The higher the percentage of production for export, the higher the permitted proportion of foreign ownership. In Malaysia one of the important tools in this structuring of foreign investment towards export was the so-called “manufacturing industry export zones” system, within which the foreign businesses functioned in what was in practice a tariff free zone, thereby not posing a threat to the local markets while creating jobs and bringing technology and expertise into the country. The purpose of this system was to protect domestic businesses acting in the domestic market from competition and price wars with foreign companies.

The Malaysian state played a significant role in promoting economic development by ensuring partial state ownership as well. Alongside banks that were owned by the state (such as Bank Negara), at the end of the 1960s the Malaysian Industrial Development Authority was created, which functioned as a state owned joint stock company. In the 1970s Petronas, the Malaysian oil and gas company was also created as a business the largest shareholder of which was the state, and to this day the state retains this status. In the meanwhile Petronas has become one of the seven largest oil companies in the world, and because of the substantial amount of foreign investment it enjoys it is often mentioned as the Malaysian multinational. Similarly, the PROTON automobile manufacturer was also founded by the state in the 1980s. Thanks to the efforts of the government to protect local enterprises, PROTON commands about 60 per cent of the domestic market, and the company has not only preserved its independence from foreign businesses, but in 1990 even acquired the English Lotus production and development unit and the Italian MV Augusta motorcycle manufacturer, as well as the Swedish Husquarna and Italian Cagiva brands, both of which had been owned by MV Augusta. Following PROTON’s successes, the domestic transportation sector also grew signifi cantly, which made it possible to found the second privately owned Malaysian automobile manufacturer, Perodu Cot. The company was created using local private capital and capital owned by the Japanese minority. Over the course of the past several years, state intervention in the Malaysian economy has slowly diminished, and foreign investors can invest in the country with a greater degree of freedom, though in the case of strategic enterprises the government continues to guard jealously its status as majority shareholder.

The growth of the Malaysian economy has been rapid since independence, but Malaysia has also been shaken by the larger global economic crises, such as the Asian crisis that hit at the end of the 1990s, though the country managed to get back on its feet reasonably quickly.

Malaysia is a good example of how a relatively small, ethnically and religiously divided country struggling with foreign policy challenges is nonetheless capable of rapid and balanced economic growth if it can find the right balance between integration into the global marketplace and defence of national interests. In order to arrive at this balance naturally the country needed leaders such as Mahatir Mohamed, who was able to hold the country together, its geographical and cultural diversity notwithstanding, for more than twenty years, and to mobilize the country’s resources in the interests of a deliberate and determined economic policy aimed at promoting gradual but continuous growth.

Translation by Thomas Cooper

(Supported by TÁMOP-4.2.1.B-11/2/KMR-2011-0002)


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